COMMENT: 'Ineffective' system should be overhauled to shift the benefit from
the well-off to the less wealthy, an academic has claimed

Pension tax breaks are 'ineffective' and 'inequitable', and should be replaced with a state handout of 50p for every £1 saved, according to a consultant to the Government. Michael Johnson, an academic at think tank the Centre for Policy Studies, said his proposals would also cap the amount of income tax refunded on pension savings at £4,000 a year. At this level savers would only need to pay £8,000 to put £12,000 into a pension – equivalent to a relief of 33pc.

The plan would hit the wealthy, who would see relief reduced and capped, but Mr Johnson argues that it would represent a simpler and fairer distribution of state savings incentives. Currently savers receive relief at their highest rate of income tax – whether 20pc, 40pc or 45pc. So it costs higher-rate taxpayers £7,200 to save £12,000, with relief available on contributions up to £40,000.

Both Labour and Liberal Democrats have set sights on redesigning the system, which represents a tax write-off worth £54bn a year.

A cynic might speculate that any reforms will be aimed at recouping some of this lost revenue to the Exchequer. Publicly, politicians will argue that the system is tilted towards the rich, leaving few benefits to the less wealthy, and so is in need of modernising. This is because higher-rate taxpayers might typically drop down an income tax bracket in retirement. Such a situation is unlikely to occur for most basic rate taxpayers, who will have merely postponed income tax rather than reduced it.

In Mr Johnson’s words, “income tax is progressive so tax relief is inevitably regressive”. He says pensions tax relief “is now lowest-hanging fruit in Whitehall” and thinks that his 50p in the £1 scheme will appeal to both Labour, which is likely to favour greater support for low-income savers, and Tories, who may take the opportunity to cut the “cost” of savings incentives.

The idea of reforming tax relief on pensions is not new. Last week, Steve Webb, the pensions minister, said he would support a flat rate of 30pc, as floated by the Pensions Policy Institute, another think tank, last year. But Mr Johnson and his Centre for Policy Studies organisation are influential and full of original thinking. His studies into the costs and benefits of pension policy sometimes spawn radical solutions that look both impractical and unlikely to win appeal among mainstream politicians.

In this case, he has included concessions to placate wealthier people who might oppose his reforms. He would reinstate the 10pc tax rebate on pension dividends, which Gordon Brown abolished as Chancellor in 1997. This has reduced pension fund values by £5bn a year ever since, estimates suggest. He would also scrap the lifetime allowance on pensions, which limits savers to amassing £1.25m within their working lives.

Thrown into the mix is a policy to offer a single annual savings allowance of £30,000 across Isas and pensions, split as the saver wishes, but with no more than £8,000 qualifying for the 50p pensions tax relief (thereby taking up £12,000 of the allowance). Contributions to final salary schemes (the few that remain open) might be exempt from this cap. Finally, he would allow savers the ability to bequeath unused money in pension pots to relatives free of inheritance tax – a policy improvement that reflects ideas expressed in this column before.

Most of these proposals appear sensible and progressive. And after the unexpected Budget reforms to give savers freedom in retirement, state intervention along these lines cannot be ruled out. But they also bring back memories of a Telegraph campaign launched in December 2012 under the banner “Hands Off Our Pensions”. The constant government raids, we said at the time, were a deterrent to saving and stoking a pensions crisis.

These assertions still ring true. The pensions system, which is one of the few state incentives to cultivate individual financial responsibility, is not perfect. But any future government considering reforms to tax relief must act in the interest of all savers, rather than a particular subsection of society, and resist the temptation to construct policy with the sole intention of filling Treasury coffers.

dan.hyde@telegraph.co.uk

The Telegraph Investor

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